Curmi & Partners

High Rates To Persist

By Simon Gauci Borda

Inflation remains high and above mandated levels but if recent communication is anything to go by then it seems as though Western Central Banks, primarily the European Central Bank and the Federal Reserve, have reached the peak of their respective hiking cycle. This comes after several months of significant hikes that began in the March 2022 when the Federal Reserve began hiking rates. However, despite recent language that rates have peaked or are close to peaking, economic data across economies may indicate that perhaps there is scope for rates to rise further.

The American consumer’s spending power remains strong due to the robust labour market. In fact, core retail sales data for the month of August showed growth of 0.1% which is lower than the prior month’s growth of 0.7% but came in better than expected. Consumer spending is expected to remain resilient despite the recent easing in the labour market as household balance sheets are still showing signs of strength.

The macroeconomic indicators in the U.S. put the widely held expectations of an upcoming slowdown at risk with the Atlanta Fed tracking 4.9% real GDP growth during the third quarter. Furthermore, the Federal Reserve’s preferred measure for inflation, i.e. core inflation, complicates the picture as to whether more rate hikes are required. Core inflation was that of 4.3% in August, which is lower than the prior month’s 4.7%, but still substantially higher than the Federal Reserve’s mandated target of 2%.

Last week the European Central Bank hiked rates for a tenth consecutive time when it announced its 25bp hike. However, the European Central Bank signalled that it likely reached “sufficiently restrictive” policy rates. The European Central Bank’s messaging during the meeting was perceived to be dovish despite the rate hike as the messaging delivered alluded to the fact that the hiking cycle may be over. Therefore, the market’s focus will now shift towards the duration for which the European Central Bank will keep policy rates at their peak before ultimately lowering them to less restrictive levels.

The current macroeconomic situation in Europe is different from the one in the U.S. While inflation remains high in Europe, economic growth in the Euro Area is weaker than the U.S. as the European Central Bank, as per its latest projection, expects economic growth of 0.7% this year which was revised downwards by 0.2% from the prior projection. Headline inflation forecasts have been revised higher to 5.6% and 3.2% for 2023 and 2024 respectively given the higher energy prices. All in all, contrary to the U.S., the European Central Bank’s forecasts paint a picture of increasing economic headwinds for the bloc.

The weaker macroeconomic backdrop in Europe is also being driven by the slowdown in the Chinese economy since European exports, primarily German exports, are reliant on Chinese consumer demand. Recent figures released show that the manufacturing sector in China is weakening while the property development sector in China, which contributes significantly to the Chinese economy, has been in decline which manifested itself with the bankruptcy of Evergrande and Country Garden amongst others.

The debate on whether peak rates have been reached has been further complicated by the recent rise in the price of oil and its effects on inflation. Since mid-June, the price of oil has risen circa 32% as oil inventories remain tight and are expected to tighten further as both OPEC+ and non-OPEC+ producers decrease production.

Whether central banks will raise rates further from current levels is still up for debate as there are several factors which may alter the path of monetary policy from current expectations. However, as per recent communication, it seems as though rates may have to remain elevated for some time to tame the high levels of inflation before less restrictive measures are taken.

The information presented in this commentary is solely provided for informational purposes and is not to be interpreted as investment advice, or to be used or considered as an offer or a solicitation to sell/buy or subscribe for any financial instruments, nor to constitute any advice or recommendation with respect to such financial instruments. Curmi and Partners Ltd. is a member of the Malta Stock Exchange and is licensed by the MFSA to conduct investment services business.